Question

1. Explain how businesses can use price elasticity of demand to make decisions about whether to raise or lower prices.

Answer 1

The principle of demand elasticity plays a crucial role in controlling prices in the pricing decisions of business firms and government. The definition of price elasticity is also critical in assessing the impact of a currency's devaluation or depreciation on its export earnings.

The market firms take into consideration the price elasticity of demand when taking pricing decisions for the products. This is because a change in a product's price will result in a decrease in the requested quantity depending on the price elasticity coefficient.This increase in quantity demanded as a result, say a company price rise, would affect the overall customer spending and thus affect the company's revenue. When the company's demand for a commodity is elastic, so any effort by the company to increase the product's price would result in a decrease in its overall sales. And instead of benefiting from the price rise, it will lose if the demand for its commodity becomes elastic. At the other hand, if a company's demand for the commodity happens to be inelastic, then it can increase its overall sales by increasing the price. Therefore the company can not disregard the market elasticity of competition for its commodity in order to set a profit-maximizing market.

Governments of several countries, especially the United States of America, offer subsidies per unit of the goods produced to farmers in order to give them incentives to produce more because, due to the inelastic nature of the market for farm products, more production causes such a steep fall in the prices of farm goods that leads to a fall in farmers' incomes. However, government in the United States has been supporting farmers over the past three decades by implementing an unusual policy of allowing them to restrict production. Forcing them to limit the government of production provides them with incentives not to plant crops on all their land (i.e. to keep some land uncultivated).